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Puerto Rico continues to attract Minnesota manufacturers

published July 2003
in Twin Cities Business Monthly (second rights to publish are for sale)

The sight of palm trees, mountains, and the ocean quickly confirm that Puerto Rico has little in common with Minnesota. Yet the Enchanted Island and the Land of Lakes have a shared interest in terms of high-skill, high-margin medical device and component manufacturing.

Until recent years, many businesses from the U.S. sought tax shelter and access to cheap labor in Puerto Rico. Drawn to Puerto Rico 20 years ago for these very reasons, Fridley, Minnesota-based Medtronic Inc. (NYSE: MDT) opened its first plant on the south central side of this Caribbean island, according to Manuel Santiago, senior director and general manager of Medtronic Puerto Rico Operations Company. The company manufactures pacemakers, defibrillators, and neurostimulation leads, components and devices used in the management of heart and brain rhythms.

"At that time Medtronic didn't know much about Puerto Rico," says Santiago. "But at that time Section 936 [of the Internal Revenue Code of the United States exempting profits or interest earned on profits that stay in Puerto Rico] and the island government offered an attractive package of incentives, such as subsidized facility rental. From then on, the other [Medtronic] facilities were brought on because of that good venture."

Following an early success in Puerto Rico, Medtronic Puerto Rico expanded to three manufacturing plants for a total of 245,000 square feet in Villalba and Humacao.

In 1988 Indianapolis-based Guidant Corporation, with operations in St. Paul (NYSE: GDT), opened a manufacturing plant in Caguas, a mountainous area south of the capital city, San Juan. The company creates mechanical heart valves used to replace a patient’s own damaged or deceased valves.

A year later, in 1989 St. Paul-based St. Jude Medical, Inc. (NYSE: STJ) opened St. Jude Medical Puerto Rico B.V. to manufacture similar products.

Now that more than a decade has passed, the reasons for bringing operations to Puerto Rico have begun to change.

The latest addition of Minnesota businesses with operations in Puerto Rico, Synovis Interventional Solutions, opened its 22,000-square-foot Synovis Caribe, April 2003 in Dorado, Puerto Rico. The location appealed to Synovis due to the proximity to buyers and the continued availability of highly skilled labor, says Synovis Life Technologies President and CEO Karen Gilles Larson.

Prior to opening its Puerto Rico plant, Synovis had been shipping Minnesota-manufactured micro-wire forms used in the maintenance of heart and brain rhythms to Puerto Rico. Demand on the island was increasing with industrial consumers, whom Gilles Larson declined to name for competitive reasons. So, even without a federal tax shelter, the deal made good business sense for Synovis.

It's Puerto Rico's educated labor pool as well as cultural, economic, and geo-political appeal that still make Puerto Rico a magnet for high-tech businesses, says Milton Segarra, Puerto Rico's Economic Development Secretary.
In terms of business culture, Puerto Rico has much in common with the United States. Puerto Rico is governed under U.S. federal law, providing a sense of security for U.S. business people, according to Segarra. Every U.S. federal agency is represented on the island, so companies work within a familiar regulatory framework.

Puerto Rico is also a bilingual country whose residents speak English and Spanish, making it ideal for companies wanting to crack the Latin American market.

Yet, manufacturing in Puerto Rico hasn't always held such appeal to high-tech businesses. The island was once known for having largely low-skilled labor for low-margin manufacturing ventures like clothing and alcoholic rum. In the twenty years, Puerto Rico has transformed itself into a world-class competitor in high-skills manufacturing.
Today, manufacturing makes up 40 percent of the island's Gross Domestic Product, according the Government Development Bank for Puerto Rico. The chemical industry accounts for 60 percent and pharmaceuticals 25 percent of the GDP. Pharmaceutical plants employ 30,000 of the 130,000 manufacturing workers.

"Especially in pharmaceuticals and high tech, Puerto Rico is one of the lead investment destinations in the world," says Segarra, competitive with Singapore and Ireland.

Talented but hungry workforce

An educated workforce is another reason why Minnesota business people say they like Puerto Rico. Of the 1,100 employees at Guidant's Dorado plant making pacemaker and defibrillator leads, 25 percent of the workers have a technical associate degree or higher.

U.S. businesses can also find their executive teams on the island.
"If you go back 20 years in time, most of the top senior management of plants were from the U.S.," says Segarra. "But because of the training and retraining of our labor force, now if you go back you'll see that the majority of the top management is local as well."

Plant manager and vice president Heriberto Díaz at Guidant del Carib; Mark Otero, general manager of General Manager Synovis Caribe; and Santiago of Medtronic are three examples of Puerto Rico-grown talent. While some of the managers have gotten their education stateside, they've all gained their experience on the island.

The acclaim of its university educational system helps Puerto Rico to enhance its workforce. The College of Engineering at the University of Puerto Rico (UPR) at Mayagüez, for instance, is an often cited training ground that ranks 12th in undergraduate enrollment among universities in the United States and 15th in the number of undergraduate degrees awarded, according to the American Society of Engineering Education (ASEE) Profiles of Engineering and Engineering Technology Colleges, 2001 Edition.

Yet, despite the industrialization and a skilled labor force, one of Puerto Rico's paradoxes is its widespread poverty. Some 44 percent of Puerto Rican families live below the federal poverty level compared to 7.9 percent in Minnesota.
Unemployment is also high, with only 45.4 percent of the working age population in the labor market. Due to the scarcity of work, Puerto Ricans may be willing to accept pay that is 33 percent less on average than that in the U.S., according to Peter Gove St. Jude's vice president of Corporate Relations.

This lower cost labor is another reason Minnesota businesses come to Puerto Rico. At Synovis, production operators in Puerto Rico earn slightly less than their Minnesota counterparts, whereas wages for professional or technical level employees are virtually identical. The company pays well above the federal minimum wage, a statutory $5.15 per hour in Puerto Rico and the United States, says Fariborz Boor-Boor, president and Chief Operating Officer at Synovis Interventional Solutions.

Santiago says his Puerto Rican factory workers make $5 to $6 an hour less than similar workers in Medtronic plants in Minnesota.

Puerto Rico provides incentives

If a highly educated, low-wage workforce gets the attention of Minnesota businesses, a menu of local tax, labor, and other incentives may keep them interested. While Puerto Rico continues to lobby Congress to renew federal income tax credits for U.S. businesses, the local government is flexing its fiscal autonomy to entice U.S. corporations in other ways.
Labor incentives, for instance, could be worth between $3,000 to $5,000 per new job, depending on the type and quantity of positions. A 15 percent deduction on Puerto Rico corporate tax is also available to manufacturers meeting certain conditions.

Non-wage-related incentives can include a 7 percent maximum local income tax rate, a deduction of up to 200 percent for research and development expenses and job training costs, and exemptions from property taxes during construction and the first year of operation, followed by a 90 percent exemption for subsequent years. The types of incentives from the Puerto Rican government are available to any qualifying business in the world, with special preference for high-tech and pharmaceutical manufacturers.

Puerto Rico Industrial Development Corporation (PRIDCO), a government agency, has even on occasion become an equity partner in opportunities that looked promising, says Segarra, though it is unclear if PRIDCO became an equity partner for any Minnesota-based businesses.

Many of these business deals appear infinitely negotiable. For instance, PRIDCO leases St. Jude 71,000 square feet of factory space at an undisclosed preferential rate. St. Jude also received a cash grant to offset the cost of training its staff and outfitting the facility with equipment. Company management would not say how much.

Medtronic leases some of its Villalba facilities from PRIDCO for less than $3 per square foot, according to Santiago. Closer to the San Juan metro area, industrial space can rent from $10 to $20 per square foot at market rate.
Guidant would not disclose the financing or incentives it received from the Puerto Rico government for its initial investment, but plant manager Díaz says infrastructure grants assisted with the purchase of machinery and air conditioning units for a recent expansion. These were equivalent to 5 to 10 percent of the overall investment, says Díaz. The government reimbursed an estimated 10 percent of the training cost and helped pay for the transfer of new technology from a Guidant plant in California in 2002, he says.

Synovis' Otero says the company will receive a break on Puerto Rico corporate taxes as well as hiring incentives if they recruit and retain 100 people in the next two years of operation. The company is leasing its building from PRIDCO and will receive less than 100 percent reimbursement for infrastructure investments to the facility.

Another factor in doing business in Puerto Rico is the high cost of energy which can run 9.3 to 15.4 cents per Kilowatt hour compared to 3.1 to 7.3 cents for industrial use in Minnesota. But Puerto Rico Electric Power Authority (PREPA) is working to keep the cost of energy under control. Until ten years ago, Puerto Rico was nearly completely dependent on crude oil. Now coal and nature gas account for 28 to 30 percent of electricity generated. To further offset spikes in energy costs, the energy authority purchases insurance hedges and can provide a 6 percent discount for businesses.

After the various incentives and discounts, manufacturing operations in Puerto Rico can ultimately cost less than those in Minnesota. Synovis' Santiago estimates doing business in Puerto could be between 20 and 30 percent cheaper, when considering differences in the cost of labor, electricity, and the cost of shipping.

Companies wanting save themselves from being bitten by federal tax on corporate earnings in 2005, can further sweeten the deal if they re-incorporate themselves as a foreign controlled corporation elsewhere—in Medtronic's case, the company chose the British Caymen islands.

Political future

Along with a lower cost of doing business, Puerto Rico hopes to use its proximity to Latin America and relationship with the United States to further its economic interests and continue to entice American businesses. For companies wanting to crack the Latin American market, the country is well poised to assist.

Its Port of the Americas project, a Post-Panamax transshipment facility—referring to the mega size of container ships that are too large to pass through the Panama Canal—is slated to open 2005 in Ponce. Ships will be able to offload their cargo onto smaller vessels and in the process theoretically export Puerto Rican manufactured goods for distribution in Latin America and elsewhere. And though Puerto Rico isn't the only island in the Caribbean with such a port—there's one in Jamaica, the Bahamas, and Curacao—it is the only island with a workforce that's sufficiently prepared for high—skill medical and technical product manufacturing.

The possibility of a Free Trade of the Americas Agreement holds promise for Puerto Rico's role in Latin America, as well. The FTAA is an expansion of the North American Free Trade Agreement led by 34 nations and business leaders to unite the economies of nearly every country in Central and South America and the Caribbean, except Cuba, into a single free trade agreement by 2005. As a bilingual country with an understanding of U.S. and Latin American cultural and business practices, Puerto Rico wants to be the commercial bridge for U.S. corporations.

"We want to be that partner to make sure that the U.S. gets the maximum outcome of those free trade agreements," says Segarra. "And obviously, Puerto Rican products have quality and follow a standard that is going to be very appealing to those Latin American markets that are included in the Free Trade of the Americas agreement."

In five to ten years, history will tell if Puerto Rico's strategy for the future and alliance with U.S. government can continue to provide a competitive advantage for U.S. businesses.

For now, Puerto Rico has enough allure to keep the Minnesota businesses coming. As Gilles Larson puts it, "I think it's a good place to do business."